If you are familiar with loan parlance, you have probably heard of the term ‘refinance’. It is possible that you have a working idea of what refinance means. However, this article aims to provide in-depth information on the subject. Read further to know more.
What is Refinance?
In the simplest of terms, ‘refinance’ or the act of ‘refinancing’ in loan parlance, means replacing an existing loan with a new one, and what you are left with; is just one loan with new lending terms and conditions. To clarify further, let’s say individual ‘A’ has an existing loan with State Bank of India. When individual ‘A’ decides that he or she needs to refinance said loan, he or she avails of the option from Axis Bank.
As a result, individual ‘A’ does not owe State Bank of India anymore, but instead owes Axis Bank and will henceforth pay off the loan amount to Axis Bank, in keeping with Axis Bank’s lending terms and conditions. This is just a hypothetical definition of what a refinancing means when put into practice.
One can refinance a wide range of existing loans, including but not limited to…
- Mortgages – are refinanced by homeowners to lower monthly payments or even to increase or decrease the repayment tenure duration on a present mortgage.
- Student Loans – are refinanced to lower interest rates on monthly loan payments if possible, or to shorten the duration of the loan repayment tenure.
- Credit Card Debt – is refinanced by way of a personal loan, to decrease interest rates paid on regular credit card debt repayments.
- Auto Loans – are refinanced in order to lower monthly payments on the original sum borrowed. This may increase the repayment tenure duration, but saves borrowers the hassle of defaulting on their debt.
- Small Business Loans – are refinanced with the objective of lowering interest rates in most cases. The idea is to restructure a loan payment plan to result in lower monthly payments, and to minimize interest charged on the original loan amount.
Lower Interest Rates
It’s easy to see that more often than not, a loan may be refinanced to reduce interest rates. Standardized interest rates are not constant and borrowers may often choose another bank or NBFC that offers to refinance a current loan on favorable terms and lower interest rates.
Features of Refinance
The features of a refinance on a current loan, depends entirely on the refinance type you are offered or opt for. The definition of the refinance types mentioned below, also shed sufficient light on the different features of a loan refinance.
- Rate and Term Refinancing – Going by the label on this kind of refinance, both the interest rate and the repayment tenure is subject to change, once the existing loan is fully repaid and is replaced by a new loan with new terms and conditions.
- Cash Out Refinancing – If you have an asset to offer as collateral, you can opt for cash out refinancing. This variation of refinancing allows you to get a new and bigger loan based on the higher monetary value of the collateral you are offering, in comparison to the original sum borrowed.
- Cash in Refinancing – facilitates lower monthly payments by replacing an existing loan with a new one, with reduced payment terms and an increased repayment tenure.
- Streamline Refinancing – mainly pertains to mortgages wherein borrowers can opt out of paying adjustable rate mortgages and graduated rate mortgages, and not only lower interest rates, but also to ensure the payment of streamlined monthly EMIs to clear a mortgage loan.
How does Refinance Affect Your Credit Score?
Many individuals considering a refinance on a current loan wonder about the impact of such a decision on one’s credit score. Yes! A refinance will have an impact on your credit score, just as a loan does. The source from which you intend to get a refinance on your existing loan, or the lender in other words, will make credit inquiries to check your eligibility. This is likely to cause your credit score to dip by a few points. As such, you need to weigh out the pros and cons of a lowered credit score in comparison to refinancing on an existing loan, and decide your next step of action.
Pros and Cons of Loan Refinance
When you opt for refinancing, you need to be aware of potential pros and cons. For your benefit, these advantages and disadvantages are highlighted in the infographic below.
| Refinance – Pros | Refinance – Cons |
| Debt consolidation that allows accumulate all dues from a number of loans, into one loan product | Loan refinancing comes with the responsibility to pay transaction fees |
| Minimizes the risks connected to defaulting on loan payments | Loan prepayment fees can be incurred |
| Lowers interest rates with some refinance products | Closing fee may be incurred before taking out a refinance |
| Decrease in monthly payments with some refinance products | Increase in repayment tenure when monthly payments are lowered |
| Helps to avoid late payments when you have multiple loan payments | Increased interest rates in some cases, making it unreasonable to opt for the refinance product being offered |
| Allows you to switch from a fixed interest rate to an adjustable interest rate/ or vice versa | Likely to lower your credit score |
How to Refinance?
Refinancing starts with looking at your options. Check out the varying refinance options offered by various banks and NBFCs and analyze terms and conditions to arrive at an alternative to your existing loan that meets your requirement. This process is likely to involve speaking to loan reps of various banks and NBFCs and working out the terms of the refinance package being offered to you. There is a chance that refinancing will not meet your requirement for lower interest rates or reduced monthly payments on your debt amount. However, if it does, the bank or NBFC you choose to go with, will help you through the refinance process.
In conclusion and bearing in mind all the information above, the refinancing process is explained well enough; for borrowers to make informed decisions when it comes to opting for this loan product.
Read Also: Mudra Loan Eligibility: Criteria and Documentation
